A/R: The keys to the kingdom

Cash is king, and healthy accounts receivable (A/R) makes for a sustainable kingdom that promotes an environment of profitability and growth. A business that doesn’t have control of its A/R usually will have poor cash flow and trouble meeting its expenses in a timely fashion. It’s often also a sign there are other financial issues that will hamper growth and sustainability.

When you sell your services you generate top line income. If you collect the money, it’s cash in the bank. But what about when you don’t collect? Obviously you create A/R but with no money in the bank. As businesspeople, we understand there’s a difference between cash and A/R. But many of us have trouble managing cash flow as opposed to managing net income. Effective A/R management is the first step in effective cash flow management.

Many of us know how to manage a profit and loss statement. However, just because we show a profit doesn’t mean there’s cash in the bank to pay the bills. Take, for example, the lawn care professional who provides services to his customers of $50,000 for a month. His technician labor, materials, vehicle costs and other direct costs amount to 50 percent or $25,000, leaving a gross margin of 50 percent. And his sales and other nondirect costs are another 35 percent or $17,500. He’s left with a 15 percent, or $7,500, net profit. Not bad! But what happens if he collects only 75 percent of his sales or $37,500? He’s owed $12,500 and is short not only his net profit of $7,500 but another $5,000 he needs to pay his bills.

Most of us understand this concept; it’s fundamental to managing a business. But why do many of us have trouble executing an effective cash management program? Are we too aggressive in trying to make that sale by giving overly generous terms to our customers? Or have we designed our business to service mostly commercial accounts that take a minimum of 30 days to pay? Under either scenario, we may not be doing the wrong thing. But we better have a plan to either collect that money quickly or access other funds or credit lines to fund the current expenses of our businesses. In terms of formulating this plan here are some factors to consider.

1. Don’t become the bank! Allowing your customers reasonable credit terms is not a bad idea. It’s when they take advantage and go beyond those terms that problems surface. Banks make bad loans, and you will have customers who don’t pay. Banks stop lending these people money. If customers don’t pay you for round one of their fertilizer program, shame on them. If you then service round two and they don’t pay, shame on you for servicing them again without payment for the first round.

2. Attack the problem. A/R management starts with laying out a formal collection procedure, which should begin with an A/R aging report. This report should categorize the firm’s receivables by age. There should be columns for current, 30, 60 and more than 90 days. At each point you should make a collection effort. In any event, don’t allow a large percentage of your receivables to go over the 60-day column. History shows the older a receivable is, the more difficult it is to collect. Making collection calls is one of the worst jobs, but some people are surprisingly good at it—and they may be right under your nose. Evaluate your team for someone with a professional presence, who is adept at handling difficult people, skilled at follow up and well organized to document collection efforts. This is the person for the job. There are also agencies you can outsource this task to.

3. Create a financial environment where days to collection with regard to A/R are less than days to payment with respect to accounts payable. This isn’t always easy. But if you give your customers 30 days to pay, see if your material suppliers will give you 60 days to pay their bills and the like. Doing so ensures you’ll have enough money coming in to meet the payments going out.

4. If you’re growing quickly, make sure you have a credit line available to fund your outstanding receivables. On several occasions I’ve been asked to help companies that are literally days away from going broke because they’re growing so quickly, extending their customers payment terms but have no cash to make payroll or pay other expenses. If you’re in this situation, you should speak to a CPA or other financial professional to do the projections necessary to secure a credit line that will allow for this growth.

A/R management is one piece of the financial and management function of growing a business. When managed properly, it allows the successful owner to operate from a position of strength and make sound business decisions about expansion, cost reduction and efficient operation of his firm.